the shrinking nest egg

The Baltimore Sun

Stash your 401(k) statements in the drawer.

The third quarter was one of bailouts, near-collapses and takeovers on Wall Street that left many mutual funds down in the dumps. Investors had few places to turn for safety. Even money-market mutual funds, considered a bedrock investment that is never supposed to lose money, fell victim to soured mortgage investments when the Reserve Primary Fund fell below $1 last month in what is commonly referred to as "breaking the buck."

All of that left mutual-fund investors with losses in the third quarter. The average U.S. diversified equity fund lost 9.96 percent, bringing the decline to 18.98 percent this year, according to mutual-fund tracker Lipper Inc.

Funds invested in once-hot market segments, such as commodities and natural resources, also fared poorly. They lost on average 11.92 percent.

And investors who turned to international markets to counter a downtrodden domestic market saw an even lousier return. The average world equity fund lost 21.02 percent, the largest single drop since 1962, according to Lipper.

"It was pretty abysmal," Baltimore money manager Douglas G. Ober said of the third quarter.

Of 215 Maryland-based stock mutual funds tracked by The Baltimore Sun, 17 made money in the three months that ended Sept. 30, according to data provided by Bloomberg News. All but two were sector funds.

The two standouts among diversified stock funds were the Hussman Strategic Growth and Legg Mason U.S. Small Cap Value Trust funds.

The Hussman fund, whose major holdings include the First American Treasury money-market fund and Johnson & Johnson, gained 3.4 percent in the quarter. Managed by Ellicott City manager John P. Hussman, the fund has gained 4.5 percent this year.

Legg Mason's small-cap fund, managed by subsidiary Brandywine Global, invests in undervalued companies that are expected to grow rapidly, such as oil and gas firm Stone Energy Corp. and chemical manufacturer Olin Corp. It showed a positive return of 2.6 percent. For the year, the Legg fund is down 8.58 percent.

Steven Tonkovich, co-manager of the Legg small-cap value fund, said the portfolio avoided or cut back on financial securities with large subprime exposure. The fund has about 35 percent invested in the sector, including banks and insurance firms.

Tonkovich noted that investors are beginning to distinguish between high-quality banks and troubled large-cap financial institutions.

Moreover, the fund's positive return in the third quarter reflects the characteristics of small-cap value funds, which "tend to be a stronger-performing group during the recession and coming out of the recession," Tonkovich said.

Of Maryland's 61 bond funds, 20 made money. The leader was Rydex Government Long Bond 1.2x Strategy A fund, which gained about 4.8 percent.

In all, Lipper analyst Tom Roseen said, 87 percent of all U.S. and global equity and mixed-equity or balanced funds lost money in the third quarter.

For a majority of investors, analysts say, opening those quarterly statements will only remind them of a depressed economy.

"Ignore the man behind the curtain," Roseen said of the statements that are expected to arrive in our mailboxes any day now. "It's all an illusion. Obviously, it's painful. We could still have more pain ahead of us."

Ober, chairman and chief executive of closed-end mutual funds Adams Express Co. and Petroleum & Resources Corp. in Baltimore, expected to see more lingering issues related to collateral debt obligations and credit default swaps in the third quarter but had hoped for improvement in the second half of 2008, "barring something dramatic happening."

To be sure, investors saw drama in the financial market. In September alone, the mortgage crisis trampled once-venerable institutions: the government takeover of mortgage giants Fannie Mae and Freddie Mac; the bankruptcy of Lehman Brothers; and the bailout of insurer American International Group. Financial institutions, such as Merrill Lynch, Washington Mutual and Wachovia Corp., also saw their fortunes fall amid the turmoil.

The Dow Jones industrial average fell 3.7 percent, and the Standard & Poor's 500 Index dropped 8.37 percent. The Nasdaq composite index lost 8.59 percent for the quarter. (The figures include dividends reinvested.)

What's more, when the House of Representative failed on the first go-around to pass a plan to bail out the financial system, stocks plunged, with the Dow falling nearly 780 points Monday, the biggest one-day point drop ever, before rebounding on the last day of the quarter.

The Senate later approved a modified $700 billion rescue plan. On Friday, the House passed the plan.

Money managers say a government bailout is warranted, though they don't expect that action alone will turn around the credit market.

James Thorne, chief investment officer at Baltimore's MTB Investment Advisors, which overseas the namesake funds, likened credit to the oil that fuels the economic engine, which has been driving without a lubricant for many miles.

"The plan puts the oil plug back in the engine, and even puts some oil back in as well," Thorne said. "But the real question is how much damage has been done to the engine."

"We have to see how it plays out," he added, noting that the first sign he'll look for is whether the depressed housing market bottoms out this spring.

Commodities-based sector funds that rewarded mutual-fund investors in the first half saw dismal returns in the third quarter, due in part to declining oil and natural resources prices.

Natural resources funds lost 32.68 percent on average in the quarter, while basic materials funds posted a negative return of 28.88 percent.

Sector funds invested in financial services and real estate came out on top, gaining 2.49 percent and 1.92 percent, respectively.

Bethesda-based ProFunds Banks UltraSector fund gained 32.28 percent in the quarter, though it's down 30.4 percent for the year.

Roseen, the Lipper analyst, said investors bought strong financial stocks on the cheap while the ban on short-selling of stocks in financial institutions helped shore up their value in the third quarter.

Investors who sought refuge in emerging markets, which showed strength in the beginning of the year, found that troubles in the U.S. spread into a "global contagion," said Roseen. The rising U.S. dollar in the quarter also hurt global equity funds, he said.

ProFunds UltraEmerging Markets fund lost 49 percent, while T. Rowe Price's fund investing in emerging markets of European and Mediterranean regions posted a negative return of 42.66 percent.

Legg Mason's renowned Value Trust fund lost 11.3 percent in the quarter, bringing the total decline to 36.68 percent for the year.

Run by Bill Miller, the Value Trust invested in a who's who of troubled companies: Freddie Mac, AIG and Merrill Lynch. Miller said recently that he and his team will spread out the fund's concentrated portfolio to include broader picks across the sectors.

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